We have a special way of looking at stocks and ETFs
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Technology advances in communications and information have transformed the way securities markets operate, and the way major investors behave as a result. Prices of equities now normally gyrate during one-year elapsed periods in ranges that are typically multiples of the underlier's trend growth.
Which means that during part of the year period their prices are retreating, and are consuming investments of time which cause the "growth" trend rates to be far less than what their better progress periods provide.
Advances in information technology encourage investment professionals (the market-making [MM] community) to protect the capital they must put at risk to do their jobs. Those actions cause the markets for equities and derivatives to become more integrated than they were in much of the 20th century.
So we study what the Pros' behavior causes to happen in the price-change "insurance" derivatives markets, to understand just how far it is reasonable to believe specific stock and ETF prices may move, both up and down, in the next few months.
This analysis has been conducted without material change daily for over a decade on more than 2500 widely-held and actively-traded stocks and ETFs. The resulting price range forecasts provide an actuarial history (unmatched elsewhere in the investment community) of subsequent market prices, as testimony to the strength or weakness of the forecasts made earlier.
Near-term price gains are most important to investors who are now either starting out in building a portfolio's wealth and exploring how it may best be done, or to investors who have come to realize that plans made years earlier are unlikely to be met at current rates of investment wealth accumulation.
Active investing, where capital is constantly put to work in the best odds-on situations to deliver profit within foreseeable time horizons, is the strategy most likely to produce what is needed, at least risk. But active investing needs guidance as to what to do, when to do it, and with what intensity.
Active Investing in Computer & Accessory Stocks
Computer stocks at this time can be good vehicles for Active Investing as a strategy for several reasons. The information technology age continues to demand these tools with ever-expanding capacities for compute power, data storage, mobility, and accessibility.
Interim setbacks and failures keep opportunity valuations in flux among many enterprises. Physical development times, marketing efforts, and peer review progress under government regulations vary across international boundaries. Competitive pressures from new organizations' blossoming successes can impact established firms.
Grandmother Snow White - International Business Machines (NYSE:IBM) is still on the scene, along with a mutation of one of the Seven Dwarfs, HP Inc. (NYSE:HPQ), but they're struggling to live with the precocious upstart Apple, Inc. (NASDAQ:AAPL) that has created a whole new competitive challenge. A competition abetted by software developers and communications technology and services providers.
Imperfect understanding of the underlying technology by investors, goaded by opportunistic enthusiasm, can create excessive stock price evaluations. Or may lead to undue interim discouragement. The appearance of new ventures has about offset the not infrequent departures. Management skill-sets sharpened by prior proven misdirection may find new utility in an environment of continually-percolating technological advances.
Figure 1 looks at the market activity and dimensions of the Computer & Accessory stocks, all of which pass our screens of comparability and attractiveness to institutional investors. There are but a score of them, and are ranked simply by market capitalization size. Those sizes range from the market's biggest to a capitalization flea of only a quarter of a $Billion.
source: Yahoo Finance
Some perspective on this data lies at the bottom of the table. There averages of the more significant columns are compared with their largest and smallest components, and with the same dimensions of the market average NYSEARCA (NYSEARCA:SPY).
For the most part these stocks are not liquid when looked at from a capital investment turnover point of view. The extremes of cap-size at the large end keep million-plus share days in the multi-year turnover range, while limited public awareness at the small end sustain that sense of illiquidity. The average is about a 5-year figure. In contrast, the market proxy ETF, SPY turns over its $200 billion market cap in two weeks, $20 billion a day.
The market activity is substantial enough to keep transaction trade spreads to an average of less than 1/20th of a percent (5 basis points) at the big-cap end, but liquidity costs start to become evident at the small-cap level, with in and out combined trade costs often at 25 to 60 basis points
Now the opportune part of the table is the typical volatility of prices in the group over the course of a year: Highs of 99% above the lows, on average. A $10,000 at the low turns into $19,900. The smallest range is a 38% gain from low to high; $10,000 into $13,800.
With that kind of volatility, where are they priced now? The average past-year Range Index (calculated the same way as a future forecast Range Index, but looking back in time, not forward) is 67. That means the group on average is priced two-thirds of the way up a zero-to-100 indexed range. Only half as much upside back to the top as downside to the bottom.
As is to be expected, some are near the top of their ranges (99) and some near their lows (13).
Few have been 2-baggers at best ($10,000 turning into $19,900), and others at worst gained just 13% ($10,000 turning into $11,300). These have been far more profitable, YTD, than SPY, where a New-Year's $10,000 has only grown to $10,800 now after reaching an interim $12,100.
But so much for history, what is yet to come? The street (sell-side) investment analysts offer 1-year price targets for many of these stocks directly, and others are imputed from current P/Es and estimated 1-year EPS collected by Yahoo Finance. On average these targets exceed present prices by +10%. A best-hope is for +45%, but with average P/Es of 29.
These street estimates for the future are tinged with employer conflicts of interest, unfortunately having been displayed many times in the past.
We find a much more reliable set of future price estimates coming from the same employers as they act in a different, but essential role. That role is as negotiators for big-money investment funds attempting to adjust the holdings in their portfolios.
Due to their typical $-billion portfolio sizes, multi-million trades would flash-crash the automated transaction system of "regular-way" trades. So such "block trades" must be negotiated between clients issuing desired trade orders and other prospective big-money investment funds to be on the other side of the trade.
It is rare to be able to "cross" the desired volume of shares at the limit price specified by the trade-originating client, so the market-maker [MM] may become a principal in the trade temporarily, picking up a long or short "stub end" of the block. But that is done only when an acceptable hedging deal can be arranged to protect the MM's capital put at market risk.
The cost of that price insurance is borne by the trade-originating client, so it must not be so large as to kill the trade. So the terms of the hedge, which define the outer limits of near-future prices of the subject stock in the block trade order, are a consensus of all three parties, the trade originator, the MM, and the seller(s) of the other side of the hedge.
It turns out that the sellers of the price protection hedge are often the proprietary trade desks of other MM firms, who are as equally well-informed as the MM firm negotiating the block trade.
Thus we have specific, honest unbiased forecasts of future price limits, both up and down, motivated by the self-serving competing interests of the participants in an open-market negotiation.
Those limits can help define prospective investment reward and risk on an issue-by-issue basis that is directly comparable between alternatives, regardless of their underlying competitive or economic circumstances. Those essential minutiae have been subsumed in the hedging negotiations.
Figure 2 uses those forecasts in making comparisons of price Risk vs. Reward tradeoffs between alternative investments.
(used with permission)
Each stock or ETF is positioned in this map by its intersection of upside price change forecast on the green horizontal scale and experienced price drawdown exposures (on the red vertical scale) typical after prior forecasts like today's. Any issue above the dotted diagonal has more potential risk than return at its present price.
A market-reference by SPY is at . Notably, none of the computer stocks has less downside risk than SPY, but all of them have higher reward prospects. The most opportune of them on a reward-to-risk equivalent line drawn from the +0 -0 "home base" through SPY and Electronics For Imaging (NASDAQ:EFII) at , is Lexmark (NYSE:LXK) at .
Since price-change risk is a dynamic, not a constant, in time these exposure relationships will change. It is these changes that provide fresh opportunities for active investment capital gains on a shorter-term recurring basis. Besides just the downside price exposure, there may be other investment attributes investors will want to consider. Figure 3 provides some of these.
Columns (5) and (6) are the source for Figure 2 coordinates. The (7) metric tells what % of the (2) to (3) range lies below (4). It discriminates among (12) prior forecasts to select the similar sample from which columns (8) to (14) data is provided. (13) compares (5)'s promise to (9)'s prior delivery; (14) compares (5) to (6). (15) is a figure of merit combining the several qualitative measures into an odds-weighted, risk-conditioned number.
For this exercise we ranked the top equity interests by the (15) figure of merit. At the bottom of the table, in blue, we have averages for the 20 Computer & Accessory stocks, along with a forecast population of 2600 stocks and ETFs, including an average of the currently best-ranked 20 issues from that population. The current parallel statistics for market-average SPY are also present.
We regard the 20 Best-Odds Forecasts as the competition in any capital commitment contest to improve a portfolio's prospects. Since Figure 3 is ranked by (15), the average of the 20 Best of (15) at 39.4 is a bogey of sorts. If half of the 20 Best (15) of 19.7 might be a lower limit, none of the stocks in Figure 3 is worth potential consideration. Super Micro Computer (NASDAQ:SMCI) is the only one that comes close.
Comparing Apple Inc. with the average of the population's 20 best-ranked stocks shows an upside forecast of +13.5% to the 20's of only 10.8%, but the best 20 won 7 out of every 8 prior forecasts to average achieved net % payoffs of +12%, including the 8th loss forecasts. AAPL won slightly more than 5 out of 8 (64 of 100) for net gains of only 2.4%.
IBM and HPQ have even more dismal outlooks, with smaller upsides in prospect, lower Win Odds, and smaller accomplished payoffs. In HPQ the Range Index of 41 provides some chance of future stock price declines or improved future price range forecasts to bring the RI down to where better Odds and Payoffs may exist.
But IBM with a low RI of 14 now and winning forecast outcomes only 41 out of 100 offers little market encouragement. The stock which 50 years ago was the market leader now has little institutional sponsorship, despite 1800+ holders.
Perhaps a time in the future will present more encouraging prospects for the computer and accessory stocks. Now does not appear to be a time for new capital commitments.
We every day examine and rank over 2,500 stocks and ETFs to find the most promising 20. No guarantees, but so far in 2016 some 2,750+ of these top 20s have shown position closeouts at a CAGR rate of 32%, while SPY has logged only 8%.
The current best 20 offer average upsides of +10.8%, with actual prior gains in the same stocks averaging +12.1% net gains under the standard TERMD discipline following forecasts just like those of today. Winning positions in those prior forecast experiences were 83 out of every 100, and worst-case price drawdowns averaged only -6.9%. Those drawdowns were recovered from in every one of the 83 average, and further on to produce gains sufficient to offset the losses in the 17 out of 100, to reach that net +10.4%.
And they did it in 42 market days, that's 2 months, so the results if repeated 6+ times in a year could produce a CAGR of +100%. These best of the forecast population are what we regard as the competition, against which other investment candidates should be compared.
Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information (earlier) helping professional and [now] individual investors discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations.
We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for their guidance what the arguably best-informed professional investors, revealed through their own self-protective hedging actions, believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, blockdesk.com has further information
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.